When You Stop Reading After The Second Sentence

On June 27, ECB President Mario Draghi opened that central bank’s international conference in Sintra, Portugal. Most media never made it past the first two sentences of his prepared remarks. For them, the verdict was already delivered in those few lines. They declared that Draghi declared monetary policy was working and the world was on its way at long last.

From there, inferences around the world flew in dizzying fashion. Much of the commentary focused on what that might mean for European monetary policy; the scaling back of QE and then the eventual raising of policy rates. It was further assumed that it must be true for the global economy if the ECB was so sure about its own case; his words were applied to the global economy, including the US, not just Europe’s.

The effect was a bond market sell-off globally that in the context of just those two lines was immediately branded as the latest BOND ROUT!!!

ECB president Mario Draghi’s upbeat speech at the ECB Forum stole the show on the markets, boosting the euro against the pound. Mr Draghi’s bullish appearance, which saw a very slight softening of his rhetoric on the ECB’s monetary policy, also strengthened the currency against a weak dollar.

That wasn’t really true, as a great many such things turn out to be quite different if you actually read past Paragraph 1. A more comprehensive, and appropriate, examination of Draghi’s remarks would have noted instead that it was his standard speech. It wasn’t anything that he hadn’t said dozens of times over the entirety of his tenure.

Thus, by saying the same thing again, the head of the ECB was actually saying quite a bit – just nothing that was really good. The main emphasis was, as always:

For central banks, this means addressing an unusual situation. We see growth above trend and well distributed across the euro area, but inflation dynamics remain more muted than one would expect on the basis of output gap estimates and historical patterns.

An accurate diagnosis of this apparent contradiction is crucial to delivering the appropriate policy response. And the diagnosis, by and large, is this: monetary policy is working to build up reflationary pressures, but this process is being slowed by a combination of external price shocks, more slack in the labour market and a changing relationship between slack and inflation. The past period of low inflation is also perpetuating these dynamics. [emphasis added; Really? A changing relationship between slack and inflation?]